Home Loan - The Avoidable Obligation ? Busting the Myth

Suppose you are planning to buy a house and you have got enough money to finance it , wont you just go ahead and buy the house of your dreams ? Without having to go through the hassles of home loan or maybe personal loan to realise your dream.  If your answer is yes , just brace yourself for one of the biggest myth buster of your life.

One of the biggest myths prevalent among Indian public, even among industry is that loan is something to be abhorred at. It is considered as a wasteful expenditure (in form of outgoing interst ) at best and a credit trap at worst. But there can be some very compelling reasons for availing loan for both individual and organisations. While for some loan is unavoidable for the need of resources, for others it may prove to be a very shrewd decision in both objective and subjective terms.

Lets explore objective analysis first –

Corporate Finance guys swear by the concept of “Opportunity Cost “.  It dictates that while calculating returns from one avenue, we should take into account expected returns from alternate avenues as well. The virtual returns that are foregone from other avenues are known as Opportunity Cost. 

Lets see how its relevant for our Case Study –

Suppose Mr. Saxena has got 30 lakhs liquid fund kitty and he is thinking of buying a home worth 32 lakhs. He was very happy assuming his decision to buy property at a very opportune time and being able to finance it as well. But then his Financial Advisor Mr. Gupta, suggested him something that just shocked him. He suggested him to avail a Home Loan. He cited mainly three reasons for the same –

1. First and foremost being Opportunity Cost of investing the money which will be rather used to pay for the home.
2. Tax Benefits of availing Home Loan
3. Better Liquidity Management

He made Mr. Saxena , understand Opportunity Cost in the following manner.

Home Loan rates typically vary from 10-11 % depending on factors like credit availability, Monetary policy of RBI , competition among banks etc etc. 

Tenure of loan varies from 10 years till 30 years.

Loan is paid back in the form of Equated Monthly Instalments (EMIs) which have a part of them consisting of interst and rest consisting of principle amount. So each month you are paying both interst and principal amount back to lender.

Talking of investments, returns may vary from secure 8 % of Fixed Deposits to anything in the range of -100% to 100% (even more) in stock markets. As demonstrated in last article, investments follow rule of compounding i.e returns of investments become investments in next investment cycle, so in a way we earn return on return as well.

Starting with this prelude, Mr. Gupta then continued with an Excel calculation (Financial Advisors can creep Excel even into Marriage) :)

Assuming that Mr. Saxena can avail at max 80% of property cost as Home Loan, he will need a Home Loan of approximate 26 lakhs ( 80% of 32 lakhs ) for a period of say 20 years , which is the most prevalent tenure of home loans.

So here is the outflow analysis in case he takes a Home Loan –

Loan Rate	Interest Payout	Tax Benefit (@10%)	Net Interst Outflow	Gross Outflow
8%	2619386	261939	2357447	4957447
10%	3421735	342174	3079562	5679562
12%	4270777	427078	3843700	6443700
14%	5159570	515957	4643613	7243613

Loan Rate = Annual Rate of Interest on the Loan availed

Interest Payout = Total Interest Paid for the tenure of loan

Tax Benefit = Total Tax Benefit (assuming an applicable Tax bracket of 10%)

Net Interest Outflow = Outflow in form of interest net of Tax Benefit

Gross Outflow = Outflow of Interest and Principal Amount, net of Tax Benefit

Now lets assume the money he saved paying to the seller, by availing loan, is invested in some funds. The corpus of this fund after 20 years (tenure of the loan) at different rate of returns will be as below –

Investment Returns	Corpus at End
6%	8338552
8%	12118489
10%	17491500
12%	25080362

Mr. Gupta is known to have a very loyal client base. Secret lies in he always planning taking in view Worst Case Scenarios. So even here he analysed taking in view worst probabilities in both Loan and Investment cases. He assumed 14% loan rate (which is as much possible as India winning Football World Cup :) ) and 6% investment returns which are lower even by prevailing assured Fixed Deposit returns of 8%.

Gross Outflow in case of 14% Home Loan is 7243613, while Gross accumulation of Investments in case of 6% Annualised Rate of Return is 8338552. A difference of 1094939 i.e. approx A WHOPPING 11 LAKHS.

So Mr. Saxena saves or earns 11 lakhs even in the worst of the worst case scenarios. Imagine his returns in case Home Loan rate is around general range of 10-11 % and returns hover in the range of 10-12%.

I will cover Tax Benefit part in coming articles. As for liquidity part, we all know that it is always easier to withdraw money from FD than from property. Isn’t it?

The learning – sometimes thinking out of the box can be really rewarding , if not only pleasantly surprising.  :)

Will keep surprising you … :) 

Portfolio Management – A Step by Step Guide

Portfolio Management, which ideally should be part of everybody’s regular – if not routine life – sadly has become a fancy term, first mention of which invites responses ranging from reluctant to scary. A number of reasons can be attributed for the same like absolute absence of financial education in school and college curriculum, relative immaturity of Indian financial industry, low level of literacy, bad legacy of certain products and constraints on marketing and promotion of financial products by Indian regulators.

In my last article I dwelt upon the importance of financial planning, lets use this opportunity to dive a bit into the intricacies of Portfolio Management, which is the most important part of financial planning, other parts being expenses planning (which is a very individual specific) and tax planning. 

A holistic Portfolio Management should start with asking certain questions in the following sequence  

     1. Why Portfolio Management?

     2. When and how much to start with?

     3. What instruments are available?

     4. How to implement it and what tools and inputs are required?

As far as WHY part is concerned, I have covered it in my last article. WHEN is something that only you can decide – I will suggest to start ASAP- and HOW MUCH is a function of primarily two parameters, one is your income and other is your recurring or unavoidable expenses. Difference of two should be your saving, but for most of us harder part is deciding and limiting the extent of expenses. My favourite solution for the same is the one suggested by Warren Buffet – save first and spend later, not the other way round. As I mentioned in my last article as well, I had debit authorisation for 1/3^rd of my salary  in place for investments before my first salary came, so I was left with only 2/3^rd of my salary to spend and hence more savings.

I will be majorly covering the HOW part in this article. WHAT part I will be covering in our next article.

HOW part is a step by step process covering following steps –

     1.Profile Determination – It is basically deciding what kind of investor you are, whether you are conservative, aggressive, risk averse, moderate etc. Following parameters decide your appetite as an investor –

1. Age – A younger investor can afford to be invested in longer horizon and comparatively riskier products.
2. Income and Expenses – As discussed, to decide the level of savings that you can afford.
3. Investment Horizon – Generally riskier products are suitable for investors having longer investment horizon.
4. Risk Appetite – It is a very subjective parameter which takes into account EQ and general risk taking ability of an individual.
5. Contingency Related Expenses– Somebody having adequate medical cover and life cover is definitely on a stronger ground than somebody lacking in the same, as he can afford to lock in substantial part in investments without having to think about contingencies which come unannounced.

I will be sharing a tool shortly which will help you in deciding your Profile.

      2.Asset Allocation – Based on Profiling, asset allocation is decided, where relative percentage of fund allocation to different asset classes is decided. Asset classes consist of majorly Aggressive, Moderate and Secured groups (More on Asset classes in next article)

      3. Instrument Allocation – Asset Allocation is followed by deciding the quantum of different investment instruments as per Asset Allocation and Investor suitability e.g. if my asset allocation dictates that I should have 30% of my corpus in Secured Assets, I need to decide how much I should allocate to different Secured instruments like FDs, Debt Funds, PPF etc. Instrument Allocation must be followed by two guiding principles –

1. No Under-diversification – Money should be distributed among a number of instruments so that Risk imbibed in different instruments is squared off. To take an example, typical wisdom says that Debt funds perform in opposite direction to Equities. Hence your portfolio should have adequate exposure to both , though relative quantum may differ based on market conditions
2.  No Over-Diversification – Earlier principle sometimes lead to investors taking exposure to too many instruments , which may prove to be counter-productive as we all know “too many cooks , spoil the meal “.  

Instrument Allocation takes following inputs into account –

1. Time Bucketing – time for which different instruments should be invested
2.  Liquidity – whether an instrument is available for withdrawal anytime or has certain restrictions.
3. Tax Implication – In a country where most of the savings are taxed at a rate as high as 33%, tax implications of the savings instruments proves to be a very critical input in decision making of asset allocation e.g while an FD may sound better than a Debt Fund as it has assured returns, situation changes once you take into account Tax implication of both.
4.  Financial Goals – All of us have some financial goals in life like MBA after 2 years, marriage after 5 years, children education etc. A good instrument allocation should take all such goals into account. Instrument allocation should be in sync with Financial Goal’s deadline and quantum.
5.  Expected and Historical Returns – while past performance of instruments can never be a robust parameter of judging a fund’s suitability, they definitely provide a good tool to analyse a fund’s relevance to one’s expectations from his portfolio. 

     4. Regular Review and Changes – while above lines may give an impression that Portfolio Management is an one shot exercise , reality is it is always an ongoing process which keeps on evolving based on changes in parameters that decided its framework. So one should review his portfolio at regular intervals to ensure that it is aligned to changing needs and market conditions.

I have been personally following the above framework for last 7 years and have found it to be an evergreen and robust approach which has stood by the various financial cycles (2008 downturn to cite one). Though everybody has his own approach and attitude towards money , I sincerely hope that my experience and learning do help you in managing your money in a more efficient and effective manner.

Keep sharing brickbats and feedback J

Life with Financial Planning - My Journey and Perspective

           “A college makes a man out of a boy “ For most of us, the most important learnings  of life come during our college days and most of the times they have got nothing to do with academics. The first and one of the most important lessons that I learnt during graduation was the importance of financial planning. I entered the college without having to bother about education loan or how to finance my education. Surprisingly everybody around had to avail loan to finance hefty fees. Before you assume that I came from a rich background, I came from a humble background, unlike my friends who came mostly from secured government job or good business background. BUT a holistic, consistent and goal oriented financial planning by my Dad ensured that I did not have to burn my mind thinking about the loan hanging on my neck even before I start earning[ if ever I get to ;) ]

This lesson became my guiding force and my own financial planning started the day I joined my first job. I started reading all sort of material related to financial planning and ensured that even before my first salary, I had debit authorisation in place for my first investments worth one third of my salary. While friends around were either yet to start thinking about financial planning or were putting their money guided by misleading bank staff having vested interests in some bad products, I was putting my money in the most tax efficient , consistent and disciplined manner. For those who are assuming me to be money minded miser living a miserable lifestyle, I can assure you my life-style was way better than most of my friends around.

           I continued with the same framework for the rest of my two years in job before I joined MBA in - no points for guessing - Finance and Marketing. Again thanks to the disciplined approach of last two years, I could manage to finance my MBA fees along with sundry expenses for next two years. MBA did manage to augment my cognitive bandwidth about finances and I learnt intricacies of financial products in and out. But thanks to my middle class upbringing I still could not digest viability, relevance and productivity of certain financial products.

Before the start of second year I got Pre-Placement Offer - first one in my batch – from the biggest Indian Automaker in their Leadership profile. About one year into the job and I realised my childhood dream, having a ceiling of my own – all by my own finances. As with the destiny, next day to my home warming day celebration I got offer from one of the leading banks in India to join their Wealth Advisory team as Wealth Advisor for their High Net worth Clients and my love became my job – best thing that can happen to anybody. As a Wealth Advisor I am known as somebody who can convince even the most conservative clients for supposedly riskier products like equity and debt related instruments. And the Big Secret of my success in managing the same lies in my own conviction in them having invested in them for the last six years myself. 

          At an age (28 years), when most of my friends are contemplating pros and cons of getting married or the parameters on which to decide the spouse, I already own flat, managed to finance MBA without any loan and recently came out of a family medical emergency that costed me more than 10 Lakh – ALL thanks to results of a holistic financial planning

          Looking in hindsight my financial planning had prove to be effective thanks to following features –

1. ·       Consistency
2. ·       Discipline
3. ·       Emotional Quotient
4. ·       Thorough Research
5. ·       Decisiveness
6. ·       Focus

        Most of us either don’t understand the power of financial planning or get intimidated by supposedly complex financial products. Trust me ITS NO ROCKET SCIENCE. Thanks to the maturity of financial products industry and pro consumer robust regulatory framework available in India, everybody and anybody can take participation in financial markets irrespective of his finance knowledge or quantum of investments he can afford , that too in most cost effective and tax efficient manner possible.

        I will be sharing with you a framework that I have developed myself as an investor and Wealth Advisor to give you a flavour how to go for financial planning in a very simple step by step manner.